By Oren Tasini, attorney
Most dealers strive to keep their dealerships in line and have a process to test legal compliance. Although a costly and time-intensive endeavor, most dealers understand that the effort is worthwhile given the large cost and hassle attendant to any lawsuit or government investigation. What is perhaps less clear to dealers is that when entering into a sale or purchase transaction, the Seller’s legal compliance — or lack thereof — can carry a high price.
One area in particular comes to mind – employee benefits and protections. In the typical asset purchase agreement the buying dealer is liable for the selling dealer’s liability in the broad area of employee benefits and protections. The concept of the purchaser’s liability for the seller’s obligations to its employees has been fashioned by the federal courts, as a matter of federal common law. The courts have found that, as matter of public policy, courts will find a successor liable for the sins of its predecessor under a number of federal statutes giving rise to employee claims in order to ensure that the individual employee is not left holding the bag. This is contrary to the common legal principle that a purchaser of assets will not assume the obligations of the seller of those assets.
In this regard, it is very common for an asset purchase agreement to contain representations and warranties from the seller in favor of the buyer that the seller has complied with all laws related to its employees. Further, the seller will agree to indemnify and defend the buyer if a lawsuit does arise. Indeed, cases under the Fair Labor Standards Act are one of the fastest growing areas of litigation. See e.g. http://www.workplaceclassaction.com/2015/03/statistics-released-by-the-administrative-office-of-the-u-s-courts-confirm-that-wage-hour-cases-represent-the-most-significant-exposure-to-employers-under-workplace-laws/.
So what does this have to do with blue sky? As we know, the bulk of purchase prices are set as a multiple of earnings. A buyer is paying based on anticipated earnings, which the buyer hopes to grow. However, if during its due diligence the buyer discovers that the dealership is not complying with wage or hour law, or a myriad of other laws and regulations, you can be sure the buyer will seek a discount on the purchase price, i.e. a reduction in blue sky.
In the fair labor standard act case, we have already determined the buyer could very well be liable directly to the seller’s employees. However, even in areas where there is no liability to a purchaser, the purchaser will still be concerned enough about non-compliance to seek a haircut. One area easily comes to mind; advertising. Given the FTC’s recent focus on dealer advertising, it is a buyer’s nightmare to buy a store and three days later have the FTC descend on the prior dealer’s employees for advertising violation. These stories generate a great deal of negative press and can significantly affect sales. I’m aware of several instances in which this has in fact occurred. Almost immediately, the value paid for the store is diminished. It is certainly something from which the dealer purchaser can recover, but in the short term it will be a drain on earnings.
Given the connection between an impaired blue sky value and violation of laws, it is important that an asset purchase agreement have representations and warranties by the seller, and the seller’s principals individually, that the seller has been in compliance with all laws. The agreement should then provide a sufficient mechanism for relief to the Buyer in the event the representations and warranties turn out to be untrue.
At a minimum, the Seller’s principal owner or owners should agree personally to defend and indemnify the buyer for any claims arising from the violation by Seller of any law. Another added layer of protection is to obtain an indemnity from an affiliate of the seller that will remain in business after the seller has gone out of business following the sale, is almost always the case.
Of course both of these safeguards depend on the “collectability” of the indemnitor, so it is worth knowing how much underwriting of the Seller can be done. For example if the Seller’s principal is married, an indemnity without spousal joinder could prove to be illusory. One should also consider the possibility of the Buyer withholding a portion of the purchase price for some period of time equal to the statute of limitations period for the longest possible period. This latter suggestion tends to a nonstarter in most negotiations, but is worth examining. Finally, and perhaps the most obvious for a known claim, is a commensurate reduction of the purchase price, which again is often met with resistance.
Given the myriad of possible claims that could be brought against a dealership, this issue of contingent liability and its impact on blue sky should not be overlooked when negotiating an asset purchase agreement. Care should be given in quantifying any exposure and then insulating the buyer against what is rightfully a liability that should be borne by the Seller and a concomitant reduction in blue sky.